Advertisement
UK markets closed
  • NIKKEI 225

    40,168.07
    -594.66 (-1.46%)
     
  • HANG SENG

    16,541.42
    +148.58 (+0.91%)
     
  • CRUDE OIL

    83.04
    +1.69 (+2.08%)
     
  • GOLD FUTURES

    2,241.10
    +28.40 (+1.28%)
     
  • DOW

    39,813.68
    +53.60 (+0.13%)
     
  • Bitcoin GBP

    55,974.66
    +1,509.56 (+2.77%)
     
  • CMC Crypto 200

    885.54
    0.00 (0.00%)
     
  • NASDAQ Composite

    16,394.53
    -4.99 (-0.03%)
     
  • UK FTSE All Share

    4,338.05
    +12.12 (+0.28%)
     

Calculating The Intrinsic Value Of NCC Group plc (LON:NCC)

Key Insights

  • NCC Group's estimated fair value is UK£1.72 based on 2 Stage Free Cash Flow to Equity

  • With UK£1.67 share price, NCC Group appears to be trading close to its estimated fair value

  • Our fair value estimate is 46% higher than NCC Group's analyst price target of UK£2.51

In this article we are going to estimate the intrinsic value of NCC Group plc (LON:NCC) by projecting its future cash flows and then discounting them to today's value. We will use the Discounted Cash Flow (DCF) model on this occasion. There's really not all that much to it, even though it might appear quite complex.

Remember though, that there are many ways to estimate a company's value, and a DCF is just one method. If you still have some burning questions about this type of valuation, take a look at the Simply Wall St analysis model.

ADVERTISEMENT

See our latest analysis for NCC Group

Is NCC Group Fairly Valued?

We're using the 2-stage growth model, which simply means we take in account two stages of company's growth. In the initial period the company may have a higher growth rate and the second stage is usually assumed to have a stable growth rate. In the first stage we need to estimate the cash flows to the business over the next ten years. Where possible we use analyst estimates, but when these aren't available we extrapolate the previous free cash flow (FCF) from the last estimate or reported value. We assume companies with shrinking free cash flow will slow their rate of shrinkage, and that companies with growing free cash flow will see their growth rate slow, over this period. We do this to reflect that growth tends to slow more in the early years than it does in later years.

A DCF is all about the idea that a dollar in the future is less valuable than a dollar today, so we discount the value of these future cash flows to their estimated value in today's dollars:

10-year free cash flow (FCF) estimate

2023

2024

2025

2026

2027

2028

2029

2030

2031

2032

Levered FCF (£, Millions)

UK£24.1m

UK£38.7m

UK£44.2m

UK£45.3m

UK£46.2m

UK£47.0m

UK£47.7m

UK£48.4m

UK£49.1m

UK£49.7m

Growth Rate Estimate Source

Analyst x6

Analyst x7

Analyst x7

Est @ 2.40%

Est @ 2.02%

Est @ 1.76%

Est @ 1.58%

Est @ 1.45%

Est @ 1.36%

Est @ 1.30%

Present Value (£, Millions) Discounted @ 9.1%

UK£22.1

UK£32.5

UK£34.0

UK£32.0

UK£29.9

UK£27.9

UK£26.0

UK£24.1

UK£22.4

UK£20.8

("Est" = FCF growth rate estimated by Simply Wall St)
Present Value of 10-year Cash Flow (PVCF) = UK£272m

After calculating the present value of future cash flows in the initial 10-year period, we need to calculate the Terminal Value, which accounts for all future cash flows beyond the first stage. The Gordon Growth formula is used to calculate Terminal Value at a future annual growth rate equal to the 5-year average of the 10-year government bond yield of 1.2%. We discount the terminal cash flows to today's value at a cost of equity of 9.1%.

Terminal Value (TV)= FCF2032 × (1 + g) ÷ (r – g) = UK£50m× (1 + 1.2%) ÷ (9.1%– 1.2%) = UK£634m

Present Value of Terminal Value (PVTV)= TV / (1 + r)10= UK£634m÷ ( 1 + 9.1%)10= UK£265m

The total value, or equity value, is then the sum of the present value of the future cash flows, which in this case is UK£537m. The last step is to then divide the equity value by the number of shares outstanding. Relative to the current share price of UK£1.7, the company appears about fair value at a 3.0% discount to where the stock price trades currently. Valuations are imprecise instruments though, rather like a telescope - move a few degrees and end up in a different galaxy. Do keep this in mind.

dcf
dcf

Important Assumptions

Now the most important inputs to a discounted cash flow are the discount rate, and of course, the actual cash flows. You don't have to agree with these inputs, I recommend redoing the calculations yourself and playing with them. The DCF also does not consider the possible cyclicality of an industry, or a company's future capital requirements, so it does not give a full picture of a company's potential performance. Given that we are looking at NCC Group as potential shareholders, the cost of equity is used as the discount rate, rather than the cost of capital (or weighted average cost of capital, WACC) which accounts for debt. In this calculation we've used 9.1%, which is based on a levered beta of 1.139. Beta is a measure of a stock's volatility, compared to the market as a whole. We get our beta from the industry average beta of globally comparable companies, with an imposed limit between 0.8 and 2.0, which is a reasonable range for a stable business.

SWOT Analysis for NCC Group

Strength

  • Earnings growth over the past year exceeded the industry.

  • Debt is not viewed as a risk.

  • Dividends are covered by earnings and cash flows.

Weakness

  • Dividend is low compared to the top 25% of dividend payers in the IT market.

Opportunity

  • Annual earnings are forecast to grow faster than the British market.

  • Good value based on P/E ratio and estimated fair value.

Threat

  • Revenue is forecast to grow slower than 20% per year.

Next Steps:

Although the valuation of a company is important, it shouldn't be the only metric you look at when researching a company. The DCF model is not a perfect stock valuation tool. Instead the best use for a DCF model is to test certain assumptions and theories to see if they would lead to the company being undervalued or overvalued. For example, changes in the company's cost of equity or the risk free rate can significantly impact the valuation. For NCC Group, we've put together three important factors you should consider:

  1. Financial Health: Does NCC have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.

  2. Future Earnings: How does NCC's growth rate compare to its peers and the wider market? Dig deeper into the analyst consensus number for the upcoming years by interacting with our free analyst growth expectation chart.

  3. Other High Quality Alternatives: Do you like a good all-rounder? Explore our interactive list of high quality stocks to get an idea of what else is out there you may be missing!

PS. Simply Wall St updates its DCF calculation for every British stock every day, so if you want to find the intrinsic value of any other stock just search here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here